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Business Law

Sharpen Your Pencils

Fashion Designers Having A Discussion

We continue now with our reflections, posted earlier (here and here), on the legal and business issues that arise when a fashion business is formed and run by two or more venturers:

You and a colleague have decided to start a new fashion business. It is best to get in writing from the start what it is you intend to do together. A non-binding but useful method is the business plan, which is typically put together to help raise funding for the venture. There is an art to creating a business plan—it has to look earnest and solidly researched, the opportunity made clear and the plan to exploit it both correct and workable. In short, it has to read like an invitation to join in executing a winning strategy. And it should be a good read. (A business plan is, after all, narrowly directed advertising.)

To start, sit down together and write out thoughts about what it is you want to accomplish. You may be surprised with what comes out. We have seen otherwise promising working relationships break up over disputes about direction and vision that could have been detected early on. You may both have agreed that handbags will be your launch product only to find, as you compose your thoughts and turn them into a plan, that you have come to believe that destiny will take you quickly into women’s scarves but that your colleague favors branching out slowly and, even then, straight into small leather goods. You will both want to have all of this buttoned up before you drop the plan onto the desk of a potential investor—or anyone else.

Beyond the business plan comes the need to document organizational responsibilities. These are private matters at first, but because they become part of both legal documents of the company and even the “culture” of your organization, they are of greater long-term importance. For example: in the event of a dispute over that or any other issue, which of you will have final say or what mechanism would you both deem to be fair to resolve the problem and move on? (If your partner is your sister, you can perhaps conference in Mom, but in most new ventures, things are rarely that simple.)

If the form of organization you choose is the limited liability company, you have a clear opportunity to set that down formally all important terms in the grounding document for the company, the operating agreement. If you choose instead to form a corporation, keep in mind that it all starts a bit differently: in the absence of an express written agreement to the contrary, majority rule is the default option. That is, the principal of one share equals one vote applies, and all power goes in the end to whoever, alone or in combination with other shareholders, controls over fifty percent of the voting shares. If no one will have a majority holding, and because you likely will want to have clear rules on more topics than just voting rights, you will be well advised to enter into a shareholders agreement. The operating agreement or the shareholders agreement should deal with all that you mean to make effective about the operation of your business—because, as your lawyer will tell you, an unwritten promise is not worth the paper on which it was not written.

However you do it, the starting point is the same: sharpen your quills and start writing—and keep at it, with counsel and advisors brought in where required—until you have created documents worthy of your best college term papers. The grade of “A” you get as a result will be reflected in the operation of a well-run and profitable business.

Credit: Alan Behr

Categories
Business Law

Getting Along–And Getting Away With It

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As we noted in an earlier post, one of the most familiar teams in fashion is the designer and his business manager, such as Yves Saint Laurent and Pierre Bergé. There are also design teams such as Domenico Dolce and Stefano Gabanna. (Taking the role of the “suit” in that family business is CEO Alfonso Dolce, who is Domenico’s brother.) If it is essentially just two of you at first, little, if anything, may end up in writing, but as your business expands, that kind of relaxed approach will become impossible to maintain. If roles and, just as important, compensation, are not formalized, misunderstandings and disputes are likely to arise. The law being about nothing if not the prevention of disputes and their resolution, we always advocate the preventative approach: set things up to prevent troubles from the start, so that they don’t jump out at you from a bend down the road—and make doing business either unnecessarily difficult or completely impossible.

Start with the form of your organization. Although it is legally possible, to a point, for two or more people just to announce they are a business and to operate as an unorganized general partnership, that is rarely a sound approach. Every partner will immediately become, and remain, personally liable for everything the business does and for its financial problems—all of them, whoever among the team may have caused them. You can make things a bit easier for yourselves by putting it in writing, but what you put in writing is critical, and it makes sense to organize in a way that limits personal liability. Keep in mind that the word partner, which has a precise legal definition, is thrown around indiscriminately these days to mean any pairing, from companies doing business together to people in love. In a general partnership, however, the old-time definition of partner applies: a co-venturer who is personally on the hook, for whatever he or she is worth and then some, for whatever debts and other liabilities the business may incur.

To prevent that from happening, two generally preferable organizational structures are available for new businesses that intend to engage in designing, manufacturing, distributing or selling fashions or accessories: the corporation and the limited liability company. They are both roads that lead to the same good end: if the business is conducted properly, its owners generally are immunized from personal liability for the actions of the company. Which organization form works better for you is a question that your legal and tax advisors will help you resolve at the time of organization.

For both forms, however, there is an important doctrine of law that has to be considered, and its consequences need to be avoided: “piercing the corporate veil.” It is every bit as brutal as it sounds. The “veil” of limited liability is “pierced” and you end up personally liable for the debts of the business, legal judgments against it, and so on. The easiest way for that to happen is for a business owner to use the company as a “mere instrumentality” for himself or herself, for example, using the business’s checking account to pay for personal obligations or otherwise comingling business and personal funds. You say you would never do that? Good. Now look over your shoulder and ask if your co-venturer is as careful in the segregation of business from personal affairs as you are. If that is not the case, it may be a good time to get the company’s attorney involved and do a business practices compliance review.

We never said that getting along is easy to do.

Credit: Alan Behr

Photo Credit: Andypiper (Creative Commons)

Categories
Business Law

You Expect Me To Talk To Lawyers?

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So much has been written and said about partnerships. Who can forget these one-liners?

“In business, if two partners always agree, there is one partner too many.”
(Or words to that effect.)

And:

“In all of love, one kisses and the other presents the cheek.”
(Generally speaking, of course.)

Both of these snatches of wisdom mean the same: when two or more people get together for anything, one of them ends up calling the shots, sooner or later.

Providing love advice falls outside the job description of the writers for these reports. (Not that we might not try our hand at it anyway when the mood overcomes us.) The point is that, in business, key roles and responsibilities need to be divided among venturers.

Business law is best practiced when the lines of communication between counsel and client are open and readily accessed. However partners may choose to organize themselves (whether as a general partnership, as a corporation, as a limited liability company, or as a non-entity or entity joint venture, to name several popular options), someone should become the prime liaison with outside counsel. If there is a legal department, that is easy: it will be one or more in-house lawyers. But in all other cases, howsoever the business is put together and operates, your lawyers need to be involved, and you will need someone to own the responsibility to communicate regularly (and proactively!) with your lawyers—even if that lucky someone happens to be you.

We are not suggesting that only one person speaks with lawyers. Business is rarely that simple. But we do note that the relationship tends to function smoothest when a skilled person within the organization who is sensitive to the legal issues that arise in the fashion business serves as the primary point of contact with counsel. So—should you be that person, and if not, who should? Ask yourself if you tell your marketers that, worst case, the lawyers can be brought in about potential problems with trademark rights for a new brand a day or two before its nationwide launch. Or consider if you occasionally suggest something such as “The contract looks fine—just sign it.” If so, you are obviously decisive and focused, but your future as legal liaison is not looking very promising—because you are potentially causing the business to run at an unacceptably high level of legal risk, and you are already announcing that you are not yet prepared to make adjustments to prevent that from happening in the future.

When people commit to do business together, they typically bring different talents and strengths into play. The most obvious example in fashion is the designer who pairs up with the business person (or as so many in my family were known, the garmento) who gets the product out the door and brings in the money. The person who is the liaison with the lawyers should be the one who understands that the legal ounce of prevention is worth the proverbial pound of cure and who can also most effectively communicate company needs to counsel and interpret and implement what comes back in response—from comments on contracts to regulatory compliance, and to litigation strategy and beyond.

It has been said that it is more fun to do business as a team than alone and that partners when truly complimentary can create and run businesses of exceptional strength. Just make sure that one of you raises his or her right hand and volunteers to stay in regular contact with counsel. Your partners will thank you for it.

With that simple but important consideration now chiseled in pixels, in our next series of posts we will offer reflections on what the law says about your rights when you team up with others.

Credit: Alan Behr

Categories
Business Law Licensing

BOTL III

During the course of negotiating a license agreement, a licensee may propose certain changes that may appear logical and reasonable. However, a licensor should be on the lookout for seemingly innocuous proposals that could impede its ability to operate its business.

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  • “I need a longer sell-off period after termination and the types of customers to which I can sell during the sell-off period [e.g., only closeout accounts] is too limiting.” Agreeing to these requests may not be problematic if no new licensee is in place, but the license agreement must contemplate the possibility that there may be a new licensee; and extended and extensive sell-off rights may make it more difficult to conclude a new license and may increase the pressure to give financial and other concessions to the new licensee. (In a later post, we will discuss the substance of sell-off provisions, including circumstances of termination that could result in a bar to a sell-off beyond the date of a termination of the license agreement.)
  • How much time does a licensee actually need, particularly considering that, for a seasonal business with a typical December 31 contract year/term end, sell-off actually could be starting as early as September?
  • While selling off prior seasons’ inventory should not seriously compete with a new licensee’s business and while closeout accounts may be the only meaningful customers for closeouts, it cannot be good for the licensor’s brand or the new licensee’s business if the former licensee’s products, whether or not they include “basics,” are being offered to the new licensee’s regular customers at the same time that the new licensee’s business is being launched.
  • “I would like an option to renew the license agreement.” While renewal options are quite common, and sometimes may even be offered by a licensor, accepting some common licensee complaints can have unintended consequences.
  • “The date by which I have to exercise the option is too early.” Depending on the length of the term, this could be a fair point, but a licensor must keep in mind that, if the option is not exercised, it will need time to locate, negotiate with and conclude an agreement with a new licensee and the new licensee will need time to develop its initial collection, which, for a seasonal business, will have to go to market well before the end of the current licensee’s agreement. (In a later post, we will discuss the need for provisions in an exclusive license allowing the licensor to engage a new licensee during the term and the new licensee to start business before the end of the term.)
  • “The conditions for renewal are not objective.” As noted in an earlier post, a licensee will want only objective standards when it comes to the conditions it will have to satisfy in order to exercise its option. However, is it unreasonable for a licensor to be able stop doing business with a licensee that, while not technically having defaulted in its obligations, has been a terrible partner and exceedingly difficult to deal with?
  • “I would like a right of first refusal for additional products or countries or trademarks.” A right of first refusal, in effect, requires the licensor to make a deal with a prospective third party licensee and then offer the current licensee the right to match it. There is not much chance that a prospective licensee will be willing to devote the time and expense of negotiating a license agreement in these circumstances. If pressed, giving the existing licensee a first right to try to make a deal with the licensor – a right of first negotiation – is a better, and reasonable, alternative.
  • “I want more countries in my licensed territory.” If a prospective licensee can demonstrate the wherewithal to properly exploit the proposed additional countries, the inclusion of the additional countries is often just a question of business judgment. (There may, however, be legal considerations to be addressed in the license agreement depending on the status of the licensor’s trademark rights in the additional countries.) If additional countries are included, though, a licensor should retain the right to take back countries that the licensee does not exploit adequately; and any such reversion right must be carefully drafted, particularly to take into account that getting back a few countries in a region may not be of any real value to the licensor. (What potential new licensee is going to be interested in a license for a few scattered Asian or European countries if the existing licensee retains the major markets in the region?) A possible compromise here might allow the licensee to keep the entire region if it is appropriately exploiting the major markets in the region, but to lose the entire region if it is not.

Credit: Jonathan R. Tillem

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Categories
Business Law Licensing

BOTL II

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When reviewing a license agreement, be on the lookout for provisions, whether boldly set forth in the “Default/Termination” section or sitting innocuously in the body of the agreement, that inappropriately (from the licensee’s perspective) may create potentially uncurable defaults or otherwise end the agreement. Some examples:

  • “Licensee shall ensure that if (a contractor or a distributor or a retailer, etc. does/does not …..).” Although a licensee should be responsible for damages to its licensor caused by a third party with which the licensee chooses to deal, should it be subject to termination if one of these third parties fails to act properly? Yet “shall ensure” means that, if the third party acts in a way that violates the license agreement requirements, an uncurable default has occurred. Go for “seek to ensure” or, better, no termination for third party acts if the licensee stops dealing with the offending third party (unless the licensee was aware/involved).
  • “Licensee may renew the license agreement if (among other things) it has maintained a performance standard acceptable to Licensor throughout the initial term.” Such a subjective standard could make the option illusory. If a licensor offers an option to renew, generally any conditions should be objective.
  • “Licensor may terminate the license agreement if Net Sales on account of sales of Licensed Products to Closeout Accounts during a Contract Year are more than X% of all Net Sales during that Year.” Licensors do not want the licensed business to evolve into a special make-up/closeout account business so, hence, they propose termination as a disincentive. Good reason, but a bit heavy-handed, so long as the licensee doesn’t make a habit of it. (Assuming an 8% royalty rate, it is fair to say that a licensee is not closing out the Licensed Products at substantial discounts to cheat the licensor out of its 8% royalty on the discounted amount, while eating the other 92% itself.)
  • “Licensor may terminate the license agreement if there are more than some number of late payments within a Contract Year or even within a period of months (even if no default notices have been sent).” Surely the licensor must have recourse if payments are habitually very late or, more clearly, if a licensee were to keep forcing a licensor to send out notices of default before curing payment defaults, but the words here also would cover a few payments arriving within a few days after they are due. I know – “no licensor would try to terminate” or “no arbiter would side with the licensor” in such a seemingly extreme case, but a line has been drawn in the license agreement. For a remedy as draconian as termination, something more should be required. While not perfect, a “no harm, no foul” window and a notice requirement would serve fairness.

Credit:  Jonathan R. Tillem

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Business Law Licensing

License Agreements: BOTL (Be On The Lookout)

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When reviewing a proposed license agreement that has been submitted by a potential licensor, Be On The Lookout for provisions that can artificially or inadvertently act to, in effect, increase the royalty rate. Some examples:

  • Gross Sales based on the wholesale or list prices rather than the actual invoice price. Is the top line on your invoice always list?
  • Unreasonably low caps on deductions permitted in calculating Net Sales. Some caps can be defensible but, if your historical rate of “discounts, allowances and returns” is higher than the cap …
  • Quarterly caps on deductions. Some quarters will have disproportionately higher shipments and the others will have disproportionately higher returns. Any cap should be based on annual sales and deductions.
  • Quarterly payments of earned royalty in excess of the quarterly minimums. If, as is common, minimum royalties will be paid quarterly in advance and if earned royalties are calculated and paid quarterly as well, the quarterly payments of earned royalty should be computed on the basis of Net Sales during the entire year through the end of the most recently completed quarter, with a credit for all minimum royalties and earned royalty previously paid for that year. (For belt and suspenders aficionados: While the formula accurately reflects the customary agreement of the parties, to avoid all possible confusion, some licensee lawyers will also request a provision to the effect that, at the end of the day, the aggregate royalty due for each year will be the higher of (a) the minimum royalty for the year and (b) the earned royalty that accrues on Net Sales during the year.)
  • A chargeback is not an allowance (and, therefore, even though the license agreement may permit deductions for allowances in calculating Net Sales, a chargeback would not be deductible unless the license agreement says it is). The lesson is that a licensee must make sure that it understands all aspects of the definition of Net Sales and that the agreement allows it to deduct all items that it would expect to be deductible. Historically, auditors claiming significant underpayments of royalties are more likely to point to improper deductions than to underreported sales.

Credit:  Jonathan R. Tillem

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